In my simple guide to the current macroeconomic
position of Greece, I said that a major mistake made by the Troika was to
insist on a pace of fiscal adjustment that was far too fast. It led to a
collapse in the economy. Of course a collapse in the economy itself raises the deficit.
So people who just look at the deficit, including many comments on that post,
say ‘what adjustment’ and ‘just how many years does Greece need’.
It is easy to avoid this trap. The OECD publishes a series for
the underlying primary balance, which is their guess at what the primary
balance (taxes less spending excl. interest payments) would be if the output
gap was zero. It is the first row in the table below: the estimated output gap
is below. I’ve also shown the scale of the decline in GDP, just to show that
the output gap numbers are pretty conservative. Unemployment in Greece is over
25%, and over half of all young people are unemployed.
2009
|
2010
|
2011
|
2012
|
2013
|
2014
|
|
Underlying
primary balance
(% of GDP)
|
-12.1
|
-6.0
|
-0.7
|
2.9
|
6.7
|
7.6
|
Output gap (%)
|
4.3
|
0.2
|
-7.1
|
-11.6
|
-14.2
|
-12.7
|
GDP growth (%)
|
-4.4
|
-5.3
|
-8.9
|
-6.6
|
-4.0
|
0.8
|
2009 was the peak underlying primary deficit, and it was huge,
representing the actions of a truly profligate government. However what
followed was complete cold turkey: within two years the underlying primary
balance was close to zero. A pretty conservative estimate for the impact of
fiscal consolidation would reduce GDP by 1% for each 1% of GDP reduction in the
primary balance. In those terms, all of the current output gap in Greece can be
explained by austerity.
As I have always said, some period involving a negative output
gap was inevitable because Greece had to regain the competitiveness it lost as
a result of the previous boom fuelled by fiscal profligacy. But slow gradual
adjustment is more efficient than cold turkey. Paul Krugman explains one reason for this: resistance to
nominal wage cuts. But there is another which is even more conventional. If we
have a Phillips curve where inflation expectations are endogenous (either
through rational or adaptive expectations) rather than anchored to some
inflation target (as Paul implicitly assumes), then competitiveness adjustment
can be achieved with a much lower cost in terms of the cumulated output gap if it is done slowly. (I gave an example here, then reacting to the idea that Latvia’s
cold turkey adjustment had been a success.)
There are only two serious barriers to this more efficient
adjustment path. The first is the willingness of some outside body to provide
the loans to fund the gradual reduction in the government’s deficit. The second
is getting those outside bodies to recognise this basic macro: austerity hits
output, and gradual adjustment is better. I think the second turned out to be
the crucial problem with Greece: as has been extensively documented, the Troika were hopelessly optimistic
about the impact cold turkey would have.
So it is as clear as it can be that the current dire position
of the Greek economy is the result of a huge mistake by the Troika. The size of
the collapse in the Greek economy is similar to the fall in Irish output during the
Great Irish Famine of 1845-53, and while the suffering in the latter is
obviously of a different order, the attitude of some in the Eurozone is as misconceived as most English politicians during the famine. Of that event they say 'God sent the blight but the English made the
famine'. In the future the Greeks may justly say ‘our politicians caused the
deficit but the Troika made the depression’.
